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Such considerations lead back to the central issue involved in every attempt to solve the economic problem arising from scarcity—how to know what to produce, and how, and how to know who should receive the fruits of production? We have seen that a decentralized market economy facilitates the solution of the economic problem by maximizing the potential discovery and utilization of relevant knowledge. Every market participant is able to bring his individual knowledge to bear on its solution, communicating his particular knowledge of conditions of demand and/or supply through his actions as buyer and/or seller, anchored in the right to private property. Knowledge of demand preferences is communicated through consumer purchases (or lack thereof), and knowledge of supply or production possibilities through the actions of producers and investors. Both kinds of knowledge, as discussed, are transmitted and coordinated through the spontaneous movement of prices. The knowledge embodied in the resulting structure of relative prices permits producers to know what consumers want (final goods), as well as the relative scarcity or abundance of needed factors of production (intermediate and producer goods). It further permits consumers and producers to know the least-cost method of fulfilling their particular needs and desires. The price system not only conveys accurate knowledge regarding the relative scarcity or abundance of resources and guides their usage accordingly but also allocates the fruits of production in accord with the subjective preferences of the consumer. As we have seen, these are impersonally “distributed” to those individuals who value them most highly, as demonstrated by their willingness to pay for them with their own resources.
The chief and insurmountable obstacle faced by central planners in a socialized economy is that the information conveyed by prices in a free-market economy is unavailable to them. As we have seen, a radically centralized economy, by definition, eliminates or circumscribes private property and transfers ultimate decisions rights over resources to public or governmental authority. The problem inherent to that form of economic organization arises from the absence of private property, which prohibits the formation of an accurate structure of relative prices. Relative prices, as we have seen, serve a crucial economic and social function: communicating accurate knowledge of the conditions of supply and demand and thereby guiding decisions relating to both production and consumption. Price signals can only perform such a function if they reflect actual conditions of supply and the actual value that people place on particular resources (demand). Such essential knowledge, however, cannot be acquired in the absence of private property. Hypothetical supply—what resources might be available for production—is of no use to economic decision makers. They must know which resources are actually available, and such information is impossible to garner in the absence of freely formed market prices that embody the dispersed knowledge of relevant sources of supply held by market participants across the globe. Similarly, hypothetical demand—what individuals might want if resources were unlimited or if they themselves did not personally have to pay for it—is illusionary demand. Such is never the human condition, characterized as it is by the inescapable fact of scarcity. What people might like to have if resources were unlimited and what they can actually afford, as a society and as individuals, are distinct issues.
In a free market freely formed relative prices reflect the truth of reality—actual demand and actual supply—but only because the institution of private property requires people to use their own limited resources every time they purchase or produce a good or service. Consumers are forced carefully to evaluate the actual value they place on contemplated purchases because they themselves will personally experience the consequences of their choice—either an increase in their subjective wellbeing or careless waste of their own scarce resources. Producers are similarly forced carefully to evaluate the actual value of the scarce resources they employ in their production decisions, since they too personally experience the consequences of their choices. If they make the correct decision—employ scarce resources efficiently in the production of items that consumers actually want—they will be rewarded with profit; if they make a mistake, they must personally suffer the loss. The discipline of the market process is crucial to a rational allocation of scarce resources, and it is utterly dependent on the institution of private property. Human beings, including governmental planners, have little incentive to be rational when spending other people’s money.
Nor is it possible for human beings, central planners again included, to behave rationally if their plans are based on imaginary resources. Rational economic decisions depend on accurate information regarding relevant conditions of supply and demand and such can only be acquired by the means of relative prices formed on the basis of private property. It is impossible to produce goods and services economically, that is, with minimum waste of scarce resources and in service of subjective human needs and wants, in the absence of accurate price information. In a socialized economy, however, the necessary condition for the formation of accurate or truthful prices—the institution of private property—is absent or truncated. The absence of freely forming relative prices means that government planners have no way of knowing the prevailing conditions of supply and demand; they must plan in the dark. They are constrained merely to guess or estimate the resources that might be available to fulfill their production plans. They must also guess or estimate the goods and services that people might want produced; they have no way of knowing their actual, and ever-changing, needs and wants. Such indeed is the fatal flaw of all highly centralized economic planning—the impossibility of rational economic calculation in the absence of accurate information regarding conditions of supply and demand. For this reason centralized economic organization has failed wherever and whenever instituted, a failure proportionate to the attempted degree of centralization or collectivization, that is, the degree to which private property rights have been curtailed. Failure in this regard means the inability to achieve the goals—the economic plans—established by the central authority. Such failure is not a result of the personal characteristics, intentions, or competence of the planners. Mother Teresa herself would be unable to acquire requisite information concerning relative scarcity and actual demand in a society without private property and thus without the ability to form an accurate structure of relative prices.
Planning without Prices
We next consider the manner in which government planners in a centralized economic system must actually prepare their plans in the absence of an accurate structure of relative prices. Planners may attempt to base such planning on historic price information, on the relative prices for resources that prevailed in the recent past, prior to establishment of the socialized economy. Alternatively, they may use certain kinds of publicly available information regarding relative prices, for instance, current world market prices for commodities such as oil, corn, copper, and so on routinely published in major newspapers. (In this regard, centrally planned systems are parasitic on the existence of free markets in other parts of the world.) Such methods, however, can never be more than makeshift approximations that do not and cannot embody existing conditions of supply and demand in a particular society. The attempt to employ historical information regarding demand (what people have valued in the past) or supply (the resources available for production in the past) to guide present production decisions is fraught with peril. Neither demand nor supply is static or constant. Every individual recognizes that his past consumption choices will not necessarily, or even probably, correspond with his future needs and wants. What people may need or want tomorrow is not necessarily what they needed or wanted yesterday. Not only do tastes change, but many other aspects of human life change continually as well. People are born and they die. They marry and have children. They divorce and live alone. They acquire pets or lose pets. They become ill or regain health. Their interests change or develop in new directions; out of the blue an individual develops an interest in learning to paint or play the piano. Neither historical nor curre
nt world-market prices can provide requisite information concerning the intrinsically unpredictable future circumstances of human existence.
Conditions of supply change continuously and unexpectedly as well. No one can control the weather; floods, droughts, and other natural disasters can and do lead to unanticipated crop failure. To illustrate the problems involved, suppose central planners devise a plan to produce ethanol for fuel. A major input into such production is corn, and thus they also incorporate a specific amount of corn into their production plans. Further suppose that the corn crop unexpectedly fails due to drought. As a result of the unforeseen weather conditions, corn producers cannot fulfill their production quotas, and this means that the ethanol producers will not be able to obtain sufficient corn to fulfill their assigned quotas. The unexpected shortages of corn and ethanol will affect numerous other industries as well—all industries whose production plans include either corn or ethanol as an input into the production of the final good. The expected inputs are not available, and all such industries will consequently be unable to fulfill their individual plans or quotas. Shortages begin to spread throughout the economy. The success of the master economic plan is dependent upon the validity of the assumption that all necessary inputs will actually be available and the further assumption that demand will remain stable and unchanging over the relevant time horizon. Both assumptions may defy reality. Many conditions of human existence are not subject to human control; moreover, they continually change and often in unanticipated ways. Human survival and wellbeing depend upon the ability flexibly and rapidly to adapt to the ever-changing conditions of existence. A planned economy cannot readily do so. The information required to become aware of changing conditions, as well as the incentives required to elicit appropriate response—freely forming relative prices and the institution of private property, respectively—either do not exist at all or, in an imperfectly centralized economy, only to a limited extent.
In a market economy, by contrast, a drought that causes failure of the corn crop will quickly manifest as a rise in the price of corn. The rise in price, as we have seen, means a rise in the potential profitability of producing corn. Private producers, seeking profit as always, have every personal incentive to shift capital resources into production of corn. Moreover, they will be able and willing to do so as rapidly as possible. Not only do they themselves possess decision rights over their personal resources but those producers first to increase production stand the best chance of earning higher-than-normal profit. Additional resources will soon be directed toward corn production, precisely what is required in response to the weather-related shortage. Planned economies do not and cannot adapt to change in a similarly swift and flexible manner. The requisite movement of relative prices is suppressed in a society that does not secure a full-throated right to private property, as are the requisite incentives for increased production (the possibility of profit, secured by property rights). For such reasons centrally planned economies are invariably characterized by chronic shortages and surpluses, chronic underproduction or overproduction. No human mind or minds, however great the political control, can identify the concrete circumstances that will prevail in the future, neither conditions of demand nor supply. All of this is to emphasize, yet again, that the economic problem, at bottom, is a knowledge problem. No human mind can foresee future events with certainty let alone attain the omniscience presupposed by central economic planning.
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Given such inevitable epistemological constraints, the question nevertheless remains: how do central planners in a socialized economy actually devise their plans in the face of their irremediable ignorance of the actual conditions of supply and demand? Their goal of course is to determine what “should” be produced and this, we shall assume, toward the end of maximizing human welfare. Such, however, is a thorny issue impervious to rational resolution. In a society of any degree of complexity, it is not possible to achieve universal agreement on what “should” be produced because universal demand for particular goods and services, in particular quantities, simply does not exist. Moreover, what “should” be produced is inevitably dependent not only on demand but also the relative scarcity or abundance of resources (supply). Because central planners have no way of acquiring accurate knowledge of either demand or supply, their plans, in the end, must be based on mere arbitrary preference, not the actual availability of limited resources or actual preferences of ultimate consumers.
To perceive more clearly the intractable problems confronting would-be central planners, assume the perspective of a governmental official assigned the task of devising plans for the production of food, a basic necessity that must of course be foremost in any economic plan. The first leg of the planning process must involve decisions concerning which food products to produce, and in what quantity. Planners will immediately encounter the fact, however, that human beings never desire or consume “food” but rather particular concrete items that fall within that abstract category—rice or potatoes, chocolate bars or chicken. From the innumerable items subsumed within the general category of “food,” planners must somehow choose which concrete items to actually produce and in what quantity. Moreover, resources are limited in a planned economy as in any other form of economic organization, and it is fair to assume that planners will aim to fulfill their plans in the least wasteful manner. To do so, they must have some means of knowing the relative availability of the various inputs involved in the production of the food items included in their plans.
For the sake of argument, further assume that the planners are benevolent and kind human beings who sincerely aim to identify food items that will be needed or desired by everyone in society. One of the first items to come to mind might be “water,” a fundamental necessity for human survival. In the language of economics, planners can confidently anticipate a universal demand for water and will thus want to include it in their production plans. We shall see, however, that even the production of an item as basic as water is not as simple as it appears. Planners must determine not only to produce water but also decide how much water and what kind of water to produce, how to produce it and who should receive it. There may exist a universal demand for water in a general and biological sense, but the quantity and kind of water demanded varies greatly from person to person. Some people love water and drink it incessantly; others hate water and drink it only under duress. Some people crave pure mineral water; others are happy with water from the tap. Some people take showers; others prefer baths. Some wash large amounts of laundry, others very little. Some water their lawns and gardens (an unpredictable need that depends on the weather); others have no lawns or gardens. Even the amount of water consumed by a particular individual will vary over time, and unpredictably; an unusually hot summer will unexpectedly increase the demand for water. And so on. In short, there is no “universal demand” for any concrete good or service, even a good as universally essential as water.
Yet planners must somehow determine the quantity and kind of water to include in their production plans, and they must do so without the guiding signals of freely formed relative prices. We assume that planners actually desire to make rational economic decisions—to employ scarce resources only in the production of goods and services that consumers actually need or want and in the least wasteful manner. Despite such good intentions, however, they cannot do so. In the absence of information conveyed by the price system, they have no means of knowing either the relative scarcity or abundance of water or the actual demand for water among the populace. We have previously discussed the problems involved is basing economic plans on historical data. In the end, the planners will have to arbitrarily decide, guess or estimate, how much and what kind of water to produce, whether or not their decision meets the actual conditions of supply (their plan may prove impossible to fulfill) or proves to satisfy actual consumer demand. Consumers will have to “make do” with whatever water is ultimately provided; one cannot consume something that has not been prod
uced.
A second example will further drive home this crucial point. Assume our planner next decides to include a breakfast beverage in his plan; most people begin their day with some form of liquid nourishment. Again, however, individual tastes vary considerably in this regard; one person likes coffee, another tea, a third cocoa, a fourth milk, a fifth orange juice, and so on. How does a planner decide which of these alternatives to produce, by what method and in what quantity? Perhaps he allows majority rule to prevail and submits the issue to the public for a vote. Such a process may satisfy the majority but only the majority. If the majority prefers tea, there will be no coffee, orange juice, cocoa, or milk to satisfy minority tastes. Indeed, any form of individual and minority taste will be difficult to satisfy in a planned economy. Central planning is a system of “one-size fits all,” tailored at best to majority tastes and, at worst, simply to the personal preferences of the planners.
A market economy, by contrast, will produce any item so long as it is profitable to do so, that is, so long as the price anyone is willing to pay for it covers its cost of production. There is no need to restrict production to only those items desired by the majority; indeed, and on the contrary, the market provides incentives for specifically catering to minority tastes. A producer can make a good living producing items demanded by relatively few consumers, such as Rolls-Royce automobiles, neon-purple nail polish, or scholarly books on freedom. All that is necessary to bring such items to market is the existence of buyers, however few, willing to pay a price that covers the cost of production, including sufficient profit to make it worth the producer’s effort and risk. Such is precisely why a market economy generates such a remarkable variety of goods and services, tailored to every conceivable taste. A centrally planned economy, by contrast, is characterized by uniformity. One cannot consume what has not been produced, and planners, if at all concerned with matching production to demand, will generally try to produce those items that will satisfy majority taste. Minorities will simply have to do without. Homogenized mass production, in the quantity determined by the central planners, is the fate of all.
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